Wednesday, April 22 2015 10:04

 Armenia's banks continue resisting external shocks, while the interval between the "shocks" is decreasing. This limits the opportunity to develop a complete system of permanent resistance to crises and prepare to repel the next shock. 

It is difficult to say if the banks will manage to meet these challenges as, according to statistics, the economy of the country's key partner Russia fell over 2% in Q1 2014 and will fall by 4% till the end of the year basing on forecasts.  Fixed capital investments in Russia fell 6% and may fall by 13%. According to preliminary forecasts, Russia's economy may have an insignificant positive dynamics only in 2017. Before that, it is necessary "to hang in here." There are many reasons of the current heavy economic situation in Armenia, but the major one is the decline of the economic activity from 7.2% to 3.4% in 2012-2014, negative economic development expectations of economic entities, stagnating real estate market, standstill in the field of the small and mid-sized enterprises (SME), reduction of the yield of big companies, and, which is not less important, slackening rates of foreign money transfers - which are necessary to support the internal demand - to a 30% forecasted decline in 2015. By the data of the World Bank, Armenia's economy depends on money transfers by labor migrants in Russia by 21%. This indicator in Georgia and Uzbekistan is much lower (by 12%), in Ukraine - 5.5% and Lithuania 4.5%. However, Tajikistan depends on money transfers from Russia by 42%, Kyrgyzstan - 31.5% and Moldova - 25%. According to the World Bank forecasts, the economic growth in Armenia in 2015 will be very low with possible positive dynamics - 0.8% (versus earlier predicted 3.3%)

In this light, Armenia's accession to the Eurasian Economic Union (EEU) is not a sheet anchor, as the integration process has not been launched yet in actual fact.
Nevertheless, yet before Armenia's accession to the EEU, on December 30 2914, the Central Bank of Armenia increased the minimal capital requirement of banks to 30 billion drams starting Jan 1 2017 (versus the current 5 billion drams). The decision aimed to ensure positive effect of the capital, make the banking activity more efficient and the banking system stable and flexible.  To meet the requirement, the banks may merge as well. So far (as of late March 2015) no bank has been merged or amalgamated. 
At present only the top-5 banks' (ACBA-Credit Agricole Bank, Ardshinbank, HSBC Bank Armenia, VTB Bank (Armenia) and Ameriabank) total capitals exceed 40 bln AMD, ranging within 42-50 bln AMD. The remaining 16 banks' capitals are lower than 30 bln AMD. 7 of them should replenish their capitals by 3-9 bln AMD (Armbusinessbank, INECOBANK, Areximbank-GPB Group, Prometey Bank, Converse Bank, Araratbank, Unibank, 5 banks - by 13-19 bln AMD (Armswissbank, Anelik Bank, Armeconombank, Artsakhbank, Mellat Bank) and 4 banks - by 20-25 bln AMD (Armenian Development Bank, ProCredit Bank, Byblos Bank Armenia, BTA Bank). Out of the specified banks, Areximbank-GPB Group was the first to replenish its capital in Q1 2015 (in January 2015 - by 9.4 bln AMD due to additional issue of shares), the second one was Prometey Bank (in early March - by 4.2 bln AMD due to the issue of long-term subordinated bonds worth 10 mln EUR), and the third one was Armeconombank (in late March - by 1.2 bln AMD through long-term subordinated borrowing from the key shareholder E.Sukiasyan and by 3.6 bln AMD in mid April through investments by the key shareholders Khachatur and Saribek Sukiasyan). As a result, Areximbank-GPB Group and Prometey Bank were able to increase their capitals to the required 30 bln AMD in Q1 2015, unlike Armeconombank, whose capital needs more tangible investments. The 16 specified banks are to increase their capitals in 2015-2016 to the 30 bln AMD to be required starting from January 2017. For the last four banks (in terms of the total capital) the matter concerns big investments. 

The financial stability management system is an important component of the banks' development strategy regardless of the ways of achieving the goals amid inorganic and organic growth. Armenian banks are still ensuring growth in the organic way (by improving the internal business processes on their own, training the personnel, enhancing the service quality, expanding and modernizing the branch network), but by 2017 some of them may have to resort to the inorganic growth method by making merger and acquisition deals.  Each of these methods may have advantages and disadvantages in each particular case. AmRating analysts think that the increase and expansion of the CB's requirements to the Basel III standards will have a positive effect on the financial stability of the banks developing the investment, corporate and retail segments of the banking system, reduce the number of actors mostly due to the drop in the number of small banks. This will allow enhancing the financial stability of the banking system attaining the goals of the banking sector development. 

To recall, the large-scale crisis of 2008 could not help affecting the banking system, which was actively financing the weakening economy at that time. When the crisis reached its peak, the lending growth rates in 2008 dropped from 73% to 51.3%, with the overdue loans growing twofold (versus the previous 23% drop) to 1.3% of the loan portfolio. As a result, the profit growth rates fell from 30% to 25%. The banks experienced a new shock in early 2009 - on March 3 the Armenian dram fell by 22%. In that situation, the resistance to challenges at all hazards delivered a strong blow to the banking sector: the profit dropped by 82% by late March 2009 amid the intensifying deterioration of the loan portfolio quality and considerable slowdown in lending. At the crisis peak in 2009 all this predicted lending decline but for the timely settlement of the resource problem by the Central Bank and the Government, which ensured the infusion from the WB's Stand-by Arrangement and the Russian stabilization loan in June. Along with this, in June 2009 the Central Bank founded the National Mortgage Company (NMC UCC) to refinance the banks' mortgage loans to support the mortgage market, which had gained momentum before the crisis. A month later, SME Investments UCC was set up under a government program to support small and medium entrepreneurship. It was due to these coordinated steps that the banks managed to retain the positive lending dynamics at 20.4% in 2009; however, the overdue loans had grown 5-fold to 5.6% of the loan portfolio by that time. This had a negative effect on the profit, which sagged by almost 50%. 

In early 2010 (February) the Government launched a program to support the mortgage market and set up the "Affordable Housing for Young Families" UCC meant to refinance the mortgage loans of the banks for specific borrowers. As a result, the lending growth rates accelerated to 28.4% amid 27% drop in overdue loans to 4.1% of the loan portfolio. The two-fold profit growth demonstrated that a big part of non- performing loans was repaid. 

In 2011, due to the launch of the government program on subsidization of agricultural loans (including subsidization from the Russian stabilization loan funds), the lending accelerated to 33.6%, but the overdue loans grew by 51% to 4.7% of the loan book, which considerably reduced the profit growth rates to 21%.  Even the shift of the focus from corporate lending to retail lending in 2011 failed to prevent the further yield loss, because the dropping creditworthiness complicated the processes of funding and management of active operations. This deteriorated the loan book quality and slackened the lending. 

In 2012, despite the continuing state program on subsidization of agricultural loans, refinancing of mortgage loans, as well as active involvement of the banks in international loan programs, the lending slackened to 21.2%, with the overdue loans increasing by 20% to 4.2% in the loan book and the profit dropping by 2%, most probably due to written-off non-performing loans accumulated during the crisis period. 
In 2013 the crisis received a new quality amid the unrecovered pre-crisis dynamics, weakened customer base of the banks and other negative factors, which did not let the financial institutions "to get a lungful of fresh air." In 2013, when the banks were actively engaged in retail rather than corporate lending, the lending slackened even more - to 14.4% amid the overdue loans' accelerated growth by 38% to 5.2% of the loan book, which prevented the profit from experiencing two-digit positive dynamics (the year 2013 saw 6% growth only).

However, the slackening retail lending from 30.5% to 19.4% in 2011-2013 demonstrated that corporate lending became a priority again. This was proved by 23.2% growth in corporate lending in 2014 versus 14.4% in 2013 and 40.5% in 2011. In the meantime, the insignificant acceleration of growth in retail lending (to 22.8% in 2014) was most likely the result of the continuous card boom (overdrafts inclusive) and the consumer loans secured by property, precious stones/metals and mortgage to some extent. 
It was thanks to this policy that the banks managed to accelerate the lending growth rates in 2014 to 22.6% mostly due to active financing of industry, agriculture, construction, public catering and services. But the overdue loans kept growing more intensively - by 78% in 2014 to 8.1% of the loan book, with 53% of the risky loans being doubtful and unrecoverable, with the latter's prevalence over the former. This could not help affecting the profit. In 2014, the financial result of the banking system dropped by 35% to 27.2 bln AMD, and in Q4 alone it dropped twofold to negative 996.5 mln AMD. 85% of the 27.2 bln AMD was the profit obtained from the currency purchase and sale, whereas in 2013 that share was 34% of the profit. 
The situation was explained by the sharp depreciation of the Armenian dram, which started in October and reached the peak on December 17. On December 3, the CB raised the lombard repo rate from 10.25% to 21%, on December 17 it toughened the reserve requirement for foreign exchange deposits from 12% to 24%, and on December 23 it raised the refinancing rate from 6.75 to 8.5%. Afterwards, the reserve requirement for foreign exchange deposits was reduced to 20% and the lombard repo rate was also reduced to 20%, with the deposit rate increased from 5.25% to 7%. At the yearend of 2014, the CB increased the minimum limit of total capital for the banks to 30 bln AMD by January 2017. 
In the meantime, to stabilize the situation in the currency market and to suppress speculations, in Dec 2014 the CB launched daily interventions in the forex interbank market. On December 8-27, the CB sold a total of $54.7 mln to the banks. On 22 Jan 2015, the CB reduced the lombard repo rate to 17% and raised the deposit rate from 8% to 9%, and the refinancing rate - to 9.5%. The lombard repo rate kept dropping: on Feb 10 - to 14.5%, on March 13 - to 13.5% and on March 23 - to 12%, with the refinancing rate raised to 10.5% and the deposit rate remaining unchanged (9%). On March 1, a zero requirement reserve mechanism was introduced for the banks, which, along with other macroprudential measures, will be a stimulus for the banks to attract long-term resources. Despite the interest rate growth (to 16-18%), the time deposit growth trend is similar to the tendency registered 4 years ago (a bit over 13%). The growth also slackened for the funds borrowed from foreign sources. This can be explained by the banks' reluctance to be in a state of bondage amid the shrinking lending market, negative forecasts for economic development and the hope to see a positive macroeconomic effect 2-3 years after Armenia's accession to the EEU (Jan 2015). On the one hand, the banks have to increase their total capitals within 2 years to remain in the market; on the other hand, they have to continue their key functions - provide loans and serve the household savings. 

In 2008-2014, the lending growth rates dropped from 51.3% to 22.6% versus the pre-crisis 73%, and the overdue loans grew from 1.1% to 8.1%, keeping increasing in absolute terms: accelerating growth in 2013- 2014 from 38% to 78% following slackening from 51% to 20% in 2011-2012. In 2013, the NPL level was far from the critical 10-15% (according to international standards), but in 2014 the deteriorating trend (8.1%) brought the NPL closely to the critical index, which cannot help causing serious concerns among a number of banks. 

The analysis of the Armenian banks' portfolios at the yearend of 2014 demonstrates that six of the banks have a critical share of overdue loans ranging within 11-32% of the loan book versus 3-8% at the yearend of 2009. The reason is the high concentration on consumer lending. Last year only two banks exceeded the critical index. In some of the banks the positive profit was replaced with a negative one; in other banks the negative profit increased even more. It is noteworthy that the banks partially supported the mortgage programs by reducing the risky consumer lending. Along with consumer loans, industry, agriculture, construction, trade, public catering and services also remain risky sectors with about 70% doubtful and unrecoverable loans, with the latter prevailing over the former mostly in industry and trade (3-4-fold year- over-year growth in unrecoverable loans). Unlike the consumer lending portfolio, whose toxic loans are easily written off by spoiling the borrowers' credit histories, the key sectors of economy enjoy the banks' understanding and are offered possible ways out of the situation, such as payment delay, prolongation, refinancing and even restructuring. However, we understand that this situation cannot last long either and that the banks need cardinal and large-scale state measures aimed at recovering the country's economic activity.